On June 24, the United States Supreme Court issued a decision in Liu v. Securities and Exchange Commission, determining whether and to what extent disgorgement is an available remedy in SEC enforcement actions under the SEC’s statutory power to obtain “any equitable relief that may be appropriate or necessary for the benefit of investors.” Justice Sotomayor, writing for every Justice except Justice Thomas (who would have held that disgorgement “can never be awarded under 15 U. S. C. §78u(d)(5)”), delivered the Court’s opinion, which held that “a disgorgement award that does not exceed a wrongdoer’s net profits and is awarded for victims is equitable relief permissible” under federal law. But the Court declined to hold whether a disgorgement award that falls short of that standard – for example, a disgorgement award that is deposited into the Treasury rather than awarded to victims, or a disgorgement award based on principles of joint-and-several liability – could also qualify. Instead, the Court left those key questions for lower courts to decide in the first instance and remanded the case for the courts below to determine whether the award sought was “consistent with equitable principles.”
The Court did, however, provide some general guidance for lower courts to consider as they fashion disgorgement awards in SEC enforcement actions (and a roadmap for defendants who may wish to challenge SEC disgorgement requests in the future). First, the Court stated that the equitable remedy of disgorgement “generally requires the SEC to return a defendant’s gains to wronged investors for their benefit.” And although the Court’s opinion did not foreclose the possibility that disgorgement awards that are not provided to victims might in some instances constitute equitable relief, it cautioned that such a remedy “must do more than simply benefit the public at large by virtue of depriving a wrongdoer of ill-gotten gains.” Second, the Court’s opinion similarly did not rule out the possibility that joint-and-several liability might be appropriate in some cases. It noted, however, that such a rule seemed generally at odds with the common-law tradition “requiring individual liability for wrongful profits,” and it spoke critically about the SEC’s practice of imposing disgorgement liability on defendants for benefits that accrue to others, which the Court said “could transform any equitable profits-focused remedy into a penalty.” Finally, the Court’s opinion explained that, in general, courts must deduct “legitimate expenses” before awarding disgorgement (unless the entire profit of the business at issue resulted from the wrongdoing). But it left the details for future courts here as well – the Court did not address what deductions are (or are not) appropriate for purposes of calculating net profits.
These issues will likely remain percolating in the lower courts – including in the remanded decision in Liu itself – and will likely reach the Supreme Court again in the coming years. At minimum, however, the Supreme Court’s decision makes clear that “traditional equitable principles” should be the guiding light for lower courts to follow as they consider these questions, and not the SEC’s more expansive longstanding practices.
Third Circuit Remands Delaware District Court Dismissal on Bank Merger
On June 18, 2020, a three-judge panel on the Third Circuit in Jaroslawicz v. M&T Bank Corporation et al., remanded a proposed class action to the Delaware district court after concluding, albeit “with caveats, cautions and qualms,” that the defendants M&T Bank Corp. and Hudson City Bancorp “failed to [properly] [inform] investors about regulatory issues” that could have been fatal to the merger.
In 2012, Hudson and M&T announced that the companies planned to merge and issued a joint proxy to their investors. As part of the required disclosures, the companies filed a single Form S-4, which required the issuer to address “the most significant factors that make an investment in the registrant or offering speculative or risky.” In the S-4, Hudson and M&T noted that M&T was subject to “extensive government regulation and supervision,” and cautioned that it “expect[ed] to face increased regulation of its industry” and could “become the subject of government and self-regulatory information-gathering requests” that could financially impact the company. The joint proxy also included other warnings explaining that the merger was subject to Federal Reserve Board evaluation and approval, noting that such evaluation included the review of the “effectiveness of the companies in combatting money laundering.” Shortly after the joint proxy was filed with the SEC and declared effective, the companies announced that regulatory approval of the merger would be delayed. In a supplemental proxy, M&T noted that the Federal Reserve Board had expressed concerns over M&T’s anti-money-laundering compliance program. Although shareholders ultimately decided to approve the merger despite the delay, it would be nearly two and half years before the merger was complete. During this time, the Consumer Financial Protection Bureau announced an enforcement action against M&T for its historical practice of charging fees on their “no-fee” accounts, which M&T settled for over two million dollars.
In October 2015, individual plaintiff shareholder David Jaroslawicz brought a proposed class action against the companies and certain executives and officers alleging that the joint proxy did not sufficiently disclose M&T’s regulatory issues in violation of Section 14(a) of the Exchange Act. Plaintiff also alleged that M&T’s failure to disclose its regulatory issues rendered the opinion statements regarding the company’s compliance practices misleading. In 2017, the district court granted M&T’s motion to dismiss the complaint, rejecting plaintiff’s arguments that M&T misled investors by failing to disclose material risk factors of the merger by not disclosing its anti-money laundering program’s noncompliance with federal law. Specifically, the district court concluded that the joint proxy did not mislead investors because it sufficiently disclosed the regulatory risks associated with the merger and because the companies were not required to disclose their consumer checking violations regarding “no fee” accounts. In 2018, the Third Circuit vacated the district court’s conclusion but later vacated its own decision on rehearing in 2019.
In its decision this month, the Third Circuit concluded that “M&T had a duty to disclose more than generic information about the regulatory scrutiny that lay ahead.” Specifically, the panel noted that, despite M&T’s knowledge that the quality of its compliance program might very well not survive the regulatory scrutiny and could “sink the merger,” the companies provided only “generic information” regarding the potential regulatory hurdle. The court acknowledged that, while M&T indeed recognized the regulatory requirements to which it would be subject, it “failed to discuss just how treacherous jumping those hoops would be. Instead, M&T offered information generally applicable to nearly any entity operating in a regulated environment.” The court clarified that regulatory enforcement actions, on their own, do not create a retroactive duty to disclose; rather, it was M&T’s knowledge that it was unlikely to survive that scrutiny that required disclosure. The Third Circuit’s decision highlights a greater level of scrutiny courts are willing to apply when companies allegedly use general disclosures to address concrete risks of which they are aware.
Poultry Industry Executives Indicted Over Price-Fixing Scheme
On June 3, 2020, the Department of Justice announced the indictment of four poultry processor industry executives of Pilgrim’s Pride and Claxton Poultry on charges of conspiracy to restrain trade by rigging bids and fixing prices for chicken products sold in the United States. The DOJ’s investigation came after food wholesalers brought a private action in 2016 against major chicken producers, including Tyson Foods and Pilgrim’s Pride, alleging that the companies conspired to fix the prices of their products. The wholesalers claimed that the chicken suppliers improperly exchanged information about prices and sales volumes, among other information. According to the indictment, wholesale purchasers of chicken products would receive bids from, or negotiate prices directly with, suppliers. The defendant suppliers allegedly undermined this process by coordinating to submit nearly identical bids—including similar prices, terms, and discount levels—to the wholesalers.
The DOJ’s investigation could well ensnare additional defendants: Tyson Foods announced on June 10, 2020, that it had “uncovered information in connection with the [DOJ] investigation,” and that it planned to cooperate with the investigation and seek leniency—likely to take advantage of the DOJ Antitrust Division’s leniency policy, which provides an opportunity for companies that are the first to cooperate to avoid criminal prosecution entirely (although this policy was expanded in 2019 to permit even subsequent cooperators to avoid prosecution). These indictments may have significant impacts on future private securities litigation, as guilty verdicts or pleas might make denial of civil claims more difficult.
Southern District of New York UPHOLDS CLAIMS against Biotech Company Regarding Discussions with the FDA
On June 17, 2020, the Southern District of New York in Skiadas v. Acer Therapeutics et al., dismissed some, but not all, claims brought in a proposed class action by investors of Acer Therapeutics (“Acer”), which alleged that the company made misleading statements regarding discussions with the FDA about its new drug application in violation of Section 10(b) of the Exchange Act and Rule 10b-5. The court concluded that investors had plausibly alleged a claim for securities fraud based on defendants’ statements about what the FDA “agreed to” with respect to the drug application, but had failed to plausibly allege that any other statements by defendants were false or misleading.
Acer, a biotechnology company specializing in the treatment of rare diseases, sought FDA approval for the use of EDSIVO, which contains celiprolol, a drug used to treat a rare genetic connective tissue disorder. In its efforts to raise capital, Acer submitted a Form 10-Q for the third quarter of fiscal year 2017 and a Preliminary Prospectus Supplement and Prospectus Supplement that included references to a September 2015 meeting with the FDA to discuss EDSIVO. The Form 10-Q stated that the agency “agreed that additional clinical development [was] not needed” and that the company could submit a New Drug Application. The 10-Q also stated that the “FDA provided [the company] with additional guidance on the expected presentation of the existing clinical data for EDSIVO to support the NDA filing.” Acer subsequently raised money from investors and submitted its NDA in October 2018, which the FDA rejected. In the agency’s decision letter, it noted that it would be “necessary to conduct an adequate and well-controlled trial to determine whether celiprolol reduc[ed] the risk of clinic events in patients.”
The court concluded that plaintiff plausibly alleged that Acer’s statements in its 2017 Offering Documents regarding the September 2015 meeting with the FDA were false or misleading, rejecting Acer’s argument that a reasonable investor would have interpreted the statements to mean that the agency had only agreed that the company would be able to submit an NDA. The court acknowledged that, while the statement was arguably ambiguous, plaintiff sufficiently alleged that the statements were false or misleading and raised a strong inference of scienter in the context of the FDA’s rejection of the NDA coupled with the decline in Acer’s stock price. However, the court concluded that the statements regarding the additional guidance related to clinical data were not false or misleading, explaining that plaintiff’s interpretation – that a reasonable investor would have understood the statement to mean that the clinical trial data was sufficient for FDA approval – was implausible and that plaintiff alleged “no facts to suggest that the FDA did not indeed provide the company this guidance.” The action serves as a warning to biotech companies to exercise caution when relaying to investors the scope and substance of discussions with the FDA.
Northern District of California Dismisses Claims Against LendingClub
On June 12, 2020 the Northern District of California, in Veal v. LendingClub Corporation, et al., dismissed a number of class action claims brought against LendingClub and its executives for alleged false and misleading statements, in violation of Section 10(b) and Rule 10b-5, related to an investigation by the Federal Trade Commission. The court concluded that plaintiffs’ second amended complaint lacked sufficient allegations to establish that LendingClub was aware of the scope and subject of the FTC’s investigations at the time the alleged false statements were made to investors. The court granted leave for plaintiffs to amend their complaint for a third time (because the second amended complaint was predicated on a new theory of liability), but dismissed without leave to amend certain allegations the court deemed non-actionable or unrelated to the action.
LendingClub, an online peer-to-peer lending company that connects borrowers and lenders in the United States, essentially serves as a broker between the parties, reviewing a borrower’s application for a loan and then matching the borrower with an appropriate lender. In May 2016, LendingClub revealed that certain executives had misled investors about the characteristics of certain loans. Specifically, the company disclosed that “material weaknesses in internal control over financial reporting” had led to self-dealing, among other things. That same month, the FTC began an investigation into the company’s conduct, and LendingClub disclosed the existence of that investigation in November 2016. On April 25, 2018, the FTC filed a complaint alleging that the company had charged up-front “hidden” fees and misled borrowers into believing that they had been approved for a loan, in addition to withdrawing more from borrowers’ accounts than was authorized and failing to provide sufficient privacy notices.
After the court dismissed plaintiffs’ Consolidated Amended Class Action complaint, plaintiffs filed a second amended complaint alleging that defendants had made false or misleading statements by failing to disclose the “thrust” of the FTC investigation. Plaintiffs identified a number of allegedly misleading statements made on earnings calls, in press releases, and in SEC filings. The court granted defendants’ motion to dismiss, concluding that plaintiffs had not sufficiently alleged that defendants knew the substance of the FTC’s investigation at the time the allegedly misleading statements referencing government investigations were made. The court further concluded that LendingClub’s statements on a May 2018 earnings call that the allegations in the FTC complaint were self-disclosed only showed that defendants were aware of the underlying issues ultimately alleged in the FTC complaint – “not that any of the [d]efendants knew the content of the FTC complaint.” Finally, the court rejected plaintiffs’ claims related to the company’s risk warnings and safe harbor statements because, although the statements referenced potential government investigations and issues related to regulatory compliance, the “outcome of the FTC Investigation had not materialized at the time the statements were made.”
The court also rejected plaintiffs’ attempt to allege scienter by relying on the “Core Operations” doctrine, which allows knowledge of certain facts to be attributed to a company’s key officers when those facts concern matters “critical to a company’s core operations.” Plaintiffs argued that because fees were a significant portion of the company’s revenue, defendants must have been aware of what the FTC was investigating. The court found that the doctrine did not apply because the issue of hidden fees did not fall within one of the “rare circumstances” where the “nature of the relevant fact” would have been so significant that it would be “absurd” that officers and executives at the company were not sufficiently aware of the problem. Rather, the court concluded, it was not “absurd” to conclude that defendants would be unaware of the substance of the FTC’s investigation before they were contacted by the agency.